Long term holds


Why do real estate private equity investors sell assets?

After all, most private owners of real estate generating really nice cashflow hold forever.

And selling forces you to either re-place the capital via a 1031 exchange under duress (eg with a short window) or to pay huge tax bills.

So, again, why do the smartest guys in the business sell?

It all comes down to the incentive structure built into the pref / promote model.

Sponsors (developers) are penalized for holding by rapidly accumulating preferred returns (eg the longer they hold the asset, the smaller their share of the eventual profit is). And their promotes (their share of the profits) are calculated based on pre-tax returns to investors, so they don’t care about the post-tax, “real” returns.

This incentive structure works well for the kind of institutional investors who back Blackstone, etc., because many of them are foundations or endowments and thus pay no taxes.

But, for an individual investor or family office, investing with a sponsor who intends to sell doesn’t make much sense.

When you have a good asset in an improving area, you put on sensible debt, and you hold it forever.